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Market Failure
Market Failure is part of the IB syllabus for microeconomics. Reasons for Market Failure • Positive and negative externalities, with appropriate diagrams Positive externalites are goods that provide benefits to third-parties who don't pay to receive these benefits. They are under-produced and are priced too low. Negative externalites are goods that impose costs to third-parties. These goods are over-produced and have a market price that is too low. • Short-term and long-term environmental concerns, with reference to sustainable development Companies tend to take on methods of production that reflects on short-term enviromental concers because of the costs of maintaining long-term awareness costs more, so the sustainability of development decreases. • Lack of public goods Lack of public goods occurs when a government does not provide goods that are not sufficiently provided in a free market. Ideally, a government would always provide all of the goods that are not sufficiently provided by a free market. Market failure occurs because the market fails without public goods; government assistance is needed to prevent market failure. One example of this are roads. Roads are not provided sufficiently by a free market. They are non-rivalrous, which means that they can be shared by more than one person simultaneously. This causes private suppliers to not provide enough roads for society. That is why they must be provided as public goods through the government. • Underprovision of merit goods Merit goods are goods that have a postive externality, meaning that an univolved third party benifits from it's production. The reason a merit good implies market failure is because the social benefit produced is not accurately reflected by the price of the good. Keeping this in mind, it is easy to understand why there is an underprovision of merit goods. These goods are undervalued, meaning that the equilibrium quantity is less than the socially optimal quantity, hence there is an underprovision of merit goods. • Overprovision of demerit goods Demerit goods produce a negative externality, meaning that a cost is incurred by an univolved third party. The equilibrium quantity of demerit goods is larger than the socially optimal quantity because of the invisible costs associated with a demerit goods. This difference in quantity produced implies that there will always be an over provision of demerit goods. • Abuse of monopoly power Monopolies are corporations that are the only companies that currently sell that product. Since they do not have any competition, like there normally would be, the monopolies have the ability to demand any price they want for the good. For people who desperately need this good, it is extremely inelastic, so they will pay no matter the cost. Seeing that they have this power with their inelastic good, monopolies can easily hike up the prices without any fear that their customers will go on to substitutes, because they are a monopoly. This will cause market failure because the the supply side isn't even affected by competition. Though monopolies create market failure, they can be used to benefit off of goods with negative externalities. Possible Government Responses to Market Failure • Legislation • Direct provision of merit and public goods Merit and public goods lead to market failure because they are non-rivalrous and non-excludable, meaning people are not willing to pay for them. This makes it difficult for a market to even exist for that good. By directly providing these goods, the government prevents market failure while also improving its infrastructure. • Taxation This is when the government jack up the price because a product is not making the profit it needs. Due to the increase of taxation, consumption will decrease because people will tend to save more than spend because the tax on the product may be more expensive than before. Also, when increasing tax, this will cause the businesses to compete with eachother on their prices. Also, there might be some underground business because products are expensive. The government can particulary tax certain private parties to reduce the amount of marginal private cost inorder for it to equal to the marginal social cost for a negative production externality. By taxing a party, they will have a higher cost when producing their goods. • Subsidies When a good has a positive externality, the government will often create a subsidy to reduce the effects of a market failure. This means that the government will give money to the party that produces this positive externality, in order to make production easier. When subsidies are given, the producers have more money to produce their goods. This will increase production, bringing the market private benefits closer to market social benefits, decreasing the positive externality, and thus stopping market failure. • Tradable permits Tradable permits put a cap on the spillover cost incurred by uninvolved third parties from production. These permits are issued from the government to firms who produce demerit goods, and the permits can be bought and sold from firm to firm. This way, firms have an incentive to become more efficient, limiting the magnitude of the negative externality. A key example of tradable permits is carbon emissions. Europe already has tradable carbon permits. • Extension of property rights Property rights are the proof of ownership that one needs in order to show ownership of property, a house, etc. It is one of the many basic rights in society. Without property rights no one would be able to show proof of any ownership over goods that may be bought. • Advertising to encourage or discourage consumption When the government uses advertising to encourage or discourage consumption or production externalities. Increases in consumption or production can affect the market. When there is a deficit, the government wants to encourage consumption or production, and when there is a surplus the government wants to discourage consumption or production. For example, climate change is a result of pollution. Pollution is a negative production externality. To bring awareness about climate change and pollution, the government and other organizations create numerous advertising like television commercials and newspaper ads informing the public. • International cooperation among governments As a response to market failures, governments and specific organizations join together to tackle externalities, generally negative externalities. The focus is to create potential methods that will equalize the marginal social cost/benefit and the marginal private cost/benefit. However, international cooperation has been shown to be not as effective as desired. One of the most recent example is the UN climate conference in Copenhagen in December 2009. The purpose of the meeting was to address the issue of carbon dioxide emission. The Copenhagen conference was considered a failure due to no establishment of a legal agreement between the 170 countries represented. There were numerous negotiation problems and many of the countries did not support the Copehagen Accord, which was proposed by the United States, India, China, South Africa, and Brazil. Category:Microeconomics